Small Cap Value Report (Wed 3 Nov 2021) - ELTA, NGHT, BMS, ZTF, WIL

Good morning, it’s Paul amp; Jack here with the SCVR for Wednesday.

Agenda -

Paul’s Section:

Electra Private Equity (LON:ELTA) (I hold) – I have a bit of a rant against Numis amp; brokers generally, who presided over the day 1 flop of this demerger (and the grotesque £11m advisor fees)

Zotefoams (LON:ZTF) – an in line trading update reassures. Increased 2022 earnings seem likely, as its markets recover from pandemic disruption. A new recyclable packaging product, ReZorce piques my interest. Potentially interesting.

Wilmington (LON:WIL) – an in line trading update. This seems a decent business, at a reasonable price.

Jack’s Section:

Nightcap (LON:NGHT) – ‘significantly ahead’ trading update brought forward ahead of final results scheduled for the 15th of November. The portfolio has roughly doubled in size to c20 sites after a placing and acquisition of Adventure Bar Group. The short term ‘invest in bars’ thesis is obvious but which operators go on to create enduring value is harder to say, which makes me more cautious given the valuations we are seeing. Trading is certainly strong here, though.

Additional comments from Paul about NGHT follow Jack’s section.

Braemar Shipping Services (LON:BMS) – shipbroker benefitting from favourable conditions. The valuation looks modest considering, but it’s a cyclical business and trends can always revert. The group is streamlining operations, disposing of non-core operations, and wants to double in size over the next few years. All in all, it looks interesting, but I do think there are risks to pay attention to as well.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover trading updates amp; results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it’s anybody’s guess what direction market sentiment will take amp; nobody can predict the future with certainty. We are analysing the company fundamentals, not trying to predict market sentiment.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed – please be civil, rational, and include the company name/ticker, otherwise people won’t necessarily know what company you are referring to.

I’ve now corrected yesterday’s report, as originally I’d put the wrong number in for the share count on Hostmore (MORE), sorry about that. Thanks to Boilermaker amp; SurreySteve for flagging my error. I forgot to add on the new shares being given to management.

Obviously Day 1 of the demerger was a flop. I did tell the company that it would need to promote the shares to private investors, since both TGI and Hotter Shoes are consumer stocks. But they didn’t, and Numis are notorious for being dismissive of private investors. £11m in fees were charged, and the demerger flopped. Pathetic! Clearly the broker didn’t do the basics, in drumming up interest in the shares.

I’ll be writing to my MP, and to Rishi Sunak, to suggest the whole system needs urgent reform. It’s seems a lucrative gravy train for advisers at the moment, not just floating companies, but also follow-on fundraisings. Investors are just being ripped off, by greedy and largely unnecessary advisers. The whole system needs drastic simplification. It should be quicker, simpler, and much cheaper, to list and refinance companies on the UK market. That would also give us some international competitive advantages, much needed in this brave new world.

We’ve had numerous frauds on the UK stock market, many of them obvious (remember the dozens of Chinese AIM frauds?!). So the onerous, expensive listing amp; refinancing rules clearly don’t prevent problems. So why have these rules?

Also, so many more things could be digitised too, e.g. voting amp; attendance at AGMs. We’ve had the technology for over 2 decades now, but vested interests seem very good at preventing its adoption. Why can’t fundraisings be digitised too, with existing shareholders being able to take up their entitlements online? It’s perfectly feasible. The costs amp; legal stuff seems largely superfluous, and many companies agree.

Anyway, it’s early days with the ELTA demerger, and I was expecting volatility, since by creating a new exit route for people who don’t want to hold either share, the price is likely to take some time to find a level were buyers amp; sellers are balanced. Hence the need to drum up buying interest.

But really, what a schoolboy error, not doing any effective PI-focused PR! Utterly basic stuff wasn’t done. I’ve done a lot more PR for them, than the brokers have, and I’m not being paid anything, as opposed to their £11m fees! It really is amazing, the way some old school brokers, especially Numis, simply don’t understand small caps – that it’s the private investors (PIs) who create market liquidity, and thereby set the price! So how does it make any sense to completely ignore, indeed repel (try getting into a company meeting at Numis!) this vital part of the market. Small cap companies shouldn’t go near Numis, in my opinion, they just don’t understand that part of the market, from what I’ve seen, and the extraction of outrageous fees, for a day 1 flop in the ELTA demerger, just reinforces this view.

EDIT: here’s yesterday’s updated/corrected spreadsheet for ELTA (I hold). The formula for google sheets is really handy, as it gives live share prices, and many of us use it to keep our portfolio spreadsheets showing live prices. I think you can do that in Excel too?

405p (up 13% at 11:21) – mkt cap £198m

Q3 Trading Update

Zotefoams, a world leader in cellular materials technology, today provides a trading update for the third quarter of its financial year ending 31 December 2021 (“Q3 2021″).

Q3 revenues have been strong -

+11% vs Q3 in 2020 (or +54% if one-off covid-related sales are removed from Q3 2020)

+35% vs Q3 2019

Strong demand

Selling prices increased in Q3 (good news)

Cost increases -

As previously communicated, the cost base of the business has increased, in part due to the start-up of our Poland facility but also due to commodity polymer price movements, general inflationary cost increases and additional costs incurred in managing current supply chain disruptions and inefficiency. We do not foresee a relaxation in cost pressure in the short to medium term.

Outlook/guidance - is in line, with a few caveats! –

We have good visibility of confirmed orders for the remainder of 2021 other than for T-FIT® insulation products, where orders are typically not confirmed until shortly before shipment and the project-based environment is more uncertain. Based on our sales forecasts and current foreign exchange rates, and subject to there being no additional material disruption to the business as a result of the ongoing supply chain challenges, the Board expects full-year revenues and profit before tax to be in line with market expectations.

… This strong commercial momentum and resilience in operational performance and cash generation gives us confidence to continue to invest for the future in all business units, with ReZorce in particular offering the potential of a very significant opportunity in the years to come”

Valuation – Arden helps out by publishing updated numbers today on Research Tree, thanks for that. FY 12/2021 is 15.2p EPS, but as we’re near the end of 2021 now, and business in 2021 was impacted in some sectors by the pandemic (e.g. automotive), then I’m more inclined to value ZTF shares on a multiple of 19.7p forecast EPS for FY 12/2022.

At 405p per share, the market is currently rating this share on 20.6 times FY 12/2022 earnings, which seems about right to me.

My opinion – 2021 earnings look to be in the bag now, with today’s in line update confirming this. There should be a decent uplift in 2022 earnings, as sectors which have lagged in 2022 hopefully return to normal, so the forecast for 2022 looks reasonable.

It might be worth readers having a look into this new ReZorce product, as the CEO suggests it could have good future potential. We only look at the numbers here, it’s not our job to try to predict what future products might do, but I do like shares where there is some potential catalyst for a future rise in valuation. This short introductory video on ReZorce sounds interesting. Do any readers know about this sector, and could give us your knowledge on whether ReZorce is something we should be getting excited about, or not? What’s the competitive environment like for this type of recyclable packaging?

Overall, I think this share looks potentially interesting.

Another interesting point to note, is that the recent sell-off in ZTF shares was spurious. That’s encouraging, as I think some investors tend to panic on a falling share price, assuming insiders must be dumping shares because the company is trading badly. That can be true, but often it isn’t true. Shares often fall because of a general market wobble, which is what I think we’ve seen recently in UK small caps, reinforcing my increasing view that we now could have a nice buying opportunity in some shares, after recent falls.

The last 3 years have been rather uninspiring for shareholders though -

232p (unchanged) – mkt cap £206m

AGM Statement (trading update)

Wilmington plc, (LSE: WIL, ‘Wilmington’ or ‘the Group’) the provider of data, information, education and training services in the global Governance, Risk and Compliance (GRC) markets, is holding its Annual General Meeting (‘AGM’) today.

It’s a brief, in line update, for FY 06/2022 –

Wilmington has made an encouraging start to the financial year and whilst significant uncertainty remains, we anticipate that the Group will trade in line with our expectations for the financial year. Cash flows have been strong, helped by the sale of a property.

Wilmington expects to publish its interim results during the week commencing 21 February 2022.

Valuation – based on 15.0p consensus EPS for FY 06/2022. That’s a PER of 15.5 times, which looks reasonable to me.

Shareholders also get a forecast 6.6p divi, yielding 2.8%

My opinion – this looks a decent business, at a reasonable price.

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Share price: 21.19p (+11.53%)

Shares in issue: 185,475,192

Market cap: £39.3m

Nightcap was launched to take advantage of the exceptional opportunity we are seeing in the market to acquire and organically grow drinks-led businesses.

It’s led by founder and CEO Sarah Wilmington, formerly involved in Bombay Bicycle Club and The Real Greek. Meanwhile, CFO Toby Rolph helped to grow the Be At One bar chain before co-leading its exit to Stonegate. The team has correctly identified a post-Covid market opportunity – they aren’t the first and won’t be the last. Which of these candidates go on to make enduring value for shareholders remains to be seen.

The group will acquire, recapitalise and develop drinks-led concepts ‘with significant potential across the UK’ and management says ‘the timing of our strategy to make selective and targeted acquisitions of individual sites, and drinks-led hospitality brands, has rarely been better.’

The thing is, lots of people know this by now. The shares reached as high as 35p back in April for a market cap of £48m on trailing twelve month revenue of £5.6m (lockdown disrupted, but still expensive).

Still, the conditions are positive, it’s an experienced management team, and the strategy reads sensibly.

The group has two concepts: London Cocktail Club (LCC), and more recently Adventure Bar Group (ABG).

Trading update the 13-weeks to 26 September 2021

Board expects results for 53 weeks ending 3 July 2022 will be significantly ahead of current market expectations

This update is being given ahead of the final year results announcement scheduled for 15 November 2021.

The first 13 weeks of the new financial year have started strongly. Pent-up demand and disposable income built-up during lock-down has seen ‘significant demand for experiential socialising’ across all the Nightcap’s cocktail bars, inside and outside of London.

Total net sales for the 13-week period of the new financial year were £7.6m, up some 68% on the same period in 2019. Like for like sales at LCC were up 52% when compared to 2019 and like for like ABG sales were up 24% for the same period in 2019. In terms of total net sales, LCC reports a 55% increase and ABG sales are up c75%.

The group’s balance sheet is solid, with cash at bank of £12.2m as at 26 September 2021 ‘remains confident about the financial year ahead’.

Three new sites are opening in November and a further 23 sites are in legal negotiations or under offer.

Sarah Willingham, CEO, commented:

I am delighted to announce this upgrade of our expectations for the 53 weeks ending 3 July 2022, as a result of such strong performance across the Group… Nightcap was built during the Covid-19 global pandemic to acquire and expand leading brands in the drinks-led bar sector and whilst the macro-economic climate remains uncertain, we believe that this uncertainty is core to our opportunity.

As anticipated, new sites are becoming available as the fallout from the pandemic continues. We expect the end of the rent moratorium in March 2022 to further improve availability of excellent sites.

Conclusion

With three new sites opening and another 23 in negotiations, this looks like a rapid expansion. The market currently presents a once-in-a-generation opportunity, so Nightcap might be in the right place at the right time, but aggressive roll outs can lead to problems down the line.

That’s usually if a company overpays for sub-optimal sites though. At the moment, companies are getting much better rents here, so that coupled with present buoyant trading bodes well in the short term.

Quantitatively, there’s not much to get excited about in the historical data so this is all about the future prospects.

On that note, revenue is forecast to jump to just under £20m by FY22 following the recent acquisition of ABG, although normalised earnings per share are expected to be just 0.67p, which suggests an FY22 PER of 28x. Perhaps after today’s announcement that figure can be beaten.

While the environment is clearly supportive, that makes it harder to understand what a newly listed bar company’s prospects are on a medium term view. The group says its concepts are strong (what company wouldn’t say that?) but the proof will be in actually visiting some of these sites, which I haven’t done yet.

In fact I have been to a London Cocktail Club, a couple of years ago on Liverpool Street. It was busy, but essentially just a well-located bar. Nothing stood out in particular but perhaps the units have been refreshed, and it would certainly be easy to roll out. ABG has seven sites after fifteen years and is described as ‘London-centric’, so I wonder if this concept will be a little harder to scale into the regions.

It’s a good time to be a small, growing, well-funded bar group but I suspect a lot of the market understands that at this point. Even after falls (Nightcap is now a Falling Star), there’s still a fair amount of growth priced in. I expect the shares to rise this morning, but the valuation makes it less immediately attractive to me as a potential investment. It’s probably a very easy time to raise money for this kind of company, which makes me cautious of newer entrants. Some of these might prove to be very successful of course.

As with Various Eateries (LON:VARE) , the primary attraction seems to be the timing and the management – here they are led by Sarah Wilmington and other experienced operators focusing on ‘simple, replicable business models with nationwide rollout potential centered around the consumer’s social experience.’ That’s sensible, and current trading is encouraging, but I imagine others will also follow this strategy in the medium term so the differentiator has to be the concept and management execution.

These are two important drivers that I don’t yet have a view on. It’s worth remembering that much more detail and commentary will likely be forthcoming in the final results.

Additional comments on Nightcap (LON:NGHT) from Paul

Paul’s comment on NGHT

Thanks to Jack for taking a look at NGHT. One thing struck me, that NGHT says it has achieved £7.6m in net sales in the most recent quarter. That’s very small. Since NGHT’s market cap of £39m is in the similar ballpark as Revolution Bars (LON:RBG) (I hold) mkt cap of £52m, then a quick comparison might be useful.

As I reported here on 7 Oct 2021, RBG generated free cashflow of £8.7m over a similar quarterly period that NGHT reports on today. RBG’s free cash generation is therefore more than NGHT’s entire revenues! NGHT doesn’t tell us anything about its cash generation, which is probably quite modest, as the business is so small currently.

Cash – NGHT says it has cash of £12.2m. It’s not clear whether this is gross, or net cash. Does the company have any debt offsetting the cash pile? It doesn’t tell us in today’s update, and being newly listed, I can’t find any published balance sheet reflecting how the company is structured now. So there’s a question mark over the balance sheet, caused by the company not making it clear in today’s announcement whether the cash it reports is gross, or net, of any net debt (ignoring leases). I can’t find anything in the admission document about debt, so I think the £12.2m cash is probably cash with no debt. If so, why wasn’t that spelt out in today’s update?

RBG last reported net cash of £3.7m at 6 Oct 2021, which had changed from a net debt position of c.£5m just 3 months earlier! Hence c.£8.7m free cashflow generation in just 3 months. I suggest that, coming into peak trading now in the run up to Christmas amp; New Years, the likelihood is that RBG could end the calendar year with a similar net cash pile to NGHT’s £12.2m.

Plus RBG has an unused c.£36.5m overdraft facility as well. Hence RBG is much better funded than NGHT to expand.

Paul’s conclusion – RBG sorted out all its problem sites in the pandemic, and got rent reductions on others, so it should be just as well placed as a start up. It’s generating astonishing free cashflow right now. The shares look dirt cheap. I think the broker forecasts look laughably wrong, so am ignoring them.

Whereas NGHT shares are a similar price, for a tiny business, that’s hoping to grow into something bigger, with all the execution risk that entails.

The valuation gap is so big that you could drive a truck through it. NGHT shareholders are hoping it will make decent cashflows in future. RBG shareholders are sitting on a business that already is generating huge cashflows. One is expensive, the other is dirt cheap, in my view.

Obviously sentiment drives share prices in the short term, but when RBG publishes its numbers properly for post-lockdown, I think the shares look very likely to significantly re-rate. Just crunch the numbers, it’s obvious! Whereas NGHT might turn out to be a good business once it’s opened lots more sites, but why would I want to pay up-front for that?

Braemar Shipping Services (LON:BMS)

Share price: 258.72p (+3.08%)

Shares in issue: 32,152,674

Market cap: £83.2m

Braemar is a leading international provider of knowledge and skill-based services to the shipping, marine, and energy industries. The group comprises four operating divisions: Shipbroking, Financial, Engineering and Logistics.

This is an area in demand globally, so trading is positive right. The shares have not rerated quite as aggressively as some of the other obvious beneficiaries of current conditions and the PEG ratio is just 0.6x.

Interim results

The board is delighted with the performance of the business in the first half, a period in which the new management team laid solid foundations from which to launch its growth strategy… Trading continues in line with the announced upgraded expectations for the full year.

Highlights:

• Revenue +11% to £47.4m,
• Underlying operating profit +10% to £5.6m,
• Forward order book has grown by 28% to $55.5m,
• Net debt has reduced by 23% to £14.7m,
• Earnings per share up from 16.2p to 18p,
• Interim dividend of 2p declared.

New strategic ambition – The board aims to double the size of Braemar’s core business over the next four years. This will come via both organic growth and complementary, value-added acquisitions, as management expects consolidation is likely in the Shipbroking space over the next few years.

The new management team is refocusing the group on its core Shipbroking and corporate finance business. Scale is increasingly important within the industry, and there is a market share and revenue diversification opportunity.

Cory Brothers is held for sale amid discussions with Vertom Agencies on a potential joint venture. The non-core investment in AqualisBraemar and its engineering division Wavespec have been disposed of. AB generated a profit on disposal of £4.4m and WS resulted in a profit on disposal of £1.6m. This has since been written down to a net loss of £0.9m however, since the buyer has not delivered on its obligations to secure a related promissory note. That doesn’t sound particularly smart. Presumably Braemar conducted some due diligence here?

Of the £11.4m of reported PBT, some £4.7m is listed as discontinued operations from the above businesses, so it looks like this is a significant streamlining.

Reported earnings per share, which includes the benefit of the sale of the non-core investment in AqualisBraemar, the restated cost of prior acquisitions and the cost of disposing of Wavespec were 36.5p, up 943% as compared with 3.5p per share in the first half of 2020/21.

The board believes that the delivery of the Group’s core strategic ambition will require both organic growth and value-added acquisitions. In addition to expanding the reach of its existing service lines, we will seek to recruit additional brokers covering not only existing products and geographies, but also new supplementary markets. We have also identified several potential complementary, value-added acquisition targets to grow our business lines. As a publicly listed market leader, we can take advantage of the likely consolidation in the Shipbroking market.

Net debt – The board previously stated that it had set a target of achieving a net debt to EBITDA ratio sustainably below 1.5 times on average over the seasonal working capital cycle.This ratio has fallen to 1.23 times for the 12 months to 31 August 2021, down from 2.03 times for the prior year.

There’s a surprising amount of goodwill on the balance sheet – £84m of the £158m in total assets, meaning net tangible asset value is actually -£20.7m, so there’s more the company could do here, particularly if it is going to pursue acquisitions, buy them, and then spend money on integrating them. The current ratio is low at 0.67x.

Outlook – The group expects that revenue and profit for the full year will exceed the previous year and meet current upgraded expectations of operating profit.

Strong trading within Shipbroking, especially Dry Cargo, Sale and Purchase, and Securities, looks set to continue H2 due to demand for the dry bulk sector, and container capacity remains high. Braemar has invested in these areas in recent years, strengthening revenue and market share.

The resurgent interest in the shipping industry from both a lending and equity investment point of view has meant that the group’s Financial Division, Braemar Naves, is trading well ahead of last year and has completed two significant transactions in the first six months of the year with a third expected to complete before the end of the financial year.

Additionally, the group’s forward order book has increased by 28% to US$55.5 million – predominantly with new building orders and Dry Cargo. Braemar also anticipates a recovery in oil-related deep sea tanker work.

James Gundy, CEO, comments:

The board has focused and delivered on simplifying the Group and reducing debt, which in turn allows us to concentrate our attention on growing our core business, something we fully understand. Scale is increasingly important within the industry, and, if we are to best service the growing needs of our clients, we must continue to provide further geographical reach and push for diversification. The board believes that building scale will further strengthen our client base, counterparties, employees and shareholders, as well as allowing us to reduce the impact of cyclical markets.

Conclusion

Strong trading within Shipbroking, especially Dry Cargo, Sale and Purchase, and Securities, looks set to continue. Braemar Naves is trading well ahead of last year. The forward order book has increased by 28% to US$55.5m, and Braemar also expects an increase in deep-sea tanker rates as oil demand recovers. This all sounds positive, and the valuation appears modest considering.

There’s the obvious news stories of general rising freight costs and the rest – at 9.7x forecast earnings and with favourable tailwinds, it’s not hard to see shares kicking on from here assuming current trends persist – but this is a cyclical business so what’s more important is whether this revamped strategy has legs.

It’s a hot sector at the minute and I’m actually surprised earnings are not up by more, but there’s more going on here than simply surfing a positive backdrop. Braemar is significantly changing – it went through a rough patch a couple of years ago and is turning around.

The group hopes to double in size over the next four years or so. If it can accomplish this and drive profits, then earnings growth and multiple expansion could translate into attractive share price returns. It’s hard to say how long current trends will last for though – they could moderate at some point over the next few years as well.

The shares look quite illiquid, with a 52% free float and an EMS of 750 suggesting you can trade around £2,000, so that’s a consideration. And I would rather the group set out on an ambitious expansion strategy from a position of greater financial strength. It’s not without risk.

On balance though, there’s enough evidence here to keep the stock interesting, and the valuation appears undemanding.

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